UTI Gilt Fund with 10 year Constant Duration: Is this a right time to invest?

UTI Gilt Fund with 10-year Constant Duration is an open-ended debt scheme that invests predominantly in government securities issued by central and state governments. The weighted average portfolio maturity will be maintained at around ten years. A reader wants to know if this is the right time to buy such a product. Also, The fund is being marketed as an attractive investment opportunity. Is really the case?

Theoretically, it seems like a sound idea. Interest rates have just started to increase. Bond yields are high. This means the market price of existing long term bonds are low. When the rates start to fall again, the prices will move up, and the NAV of gilt funds will shoot up.

Practically, there are many uncertainties. If the rates continue to increase, a fund like UTI Gilt Fund with a 10-year Constant Duration will continue to bleed. If the rates do not increase for a while, then the NAV will move up or down much. If the rates are lowered, the expected gain may not be as imagined.

Unlike a normal gilt fund that behaves like a dynamic bond fund and freely changes the portfolio average maturity, this new offering is constrained to keep the value close to 10 years. This means the portfolio will always have long-term to very long-term bonds.  The NAV of such a fund will be the most volatile among all debt funds.

Gilt Funds with a 10-year Constant Duration are suitable only for experienced debt mutual fund investors who do not mind waiting for months or even years for NAV recovery and can withstand sharp falls, even a crash! In July 2013, when the Rupee was weak, RBI aggressively hiked the repo rate leading to a crash in the bond market. If such an event recurs, such a fund will not only be hit the hardest but will also take the longest to recover.

To appreciate how much returns can fluctuate, see Gilt mutual funds will not protect your money! Recognize risks before investing!

The primary advantage of such funds is fund management risk associated with duration play is lower than gilt funds. That is, in a normal gilt, the fund has the freedom to change bond tenure, as mentioned above. This may or may not result in higher returns. At times, their calls can go wrong. This risk is lower in a constant duration fund (but not eliminated).

For investors who can stomach associated risks, we recommend two ways to use UTI Gilt Fund with a 10-year Constant Duration (or similar funds)

1. Use for very long term goals along with equity and debt instruments. Regular rebalancing is essential.  Experienced investors with a large corpus can afford to hold such funds even after retirement. The risk here is that one has to endure poor sequences of returns that may last months or even years. We prefer this method.
   • Investors who prefer less volatile debt funds may consider gilt funds or corporate bond funds for long-term goals. See: What debt fund should I add to a long term investment portfolio?
2. Buy and sell tactically with a proper qualitative (macro-economic indicator-based) or quantitative strategy. This may backfire at times. We have backtested a quantitative strategy and created a double-moving average tool. The latest backtest results are here: Is it possible to time entry and exit from gilt mutual funds for better returns? Caution: No strategy will work all the time.

Resources:

• For an overview of the basis, see FAQ on gilt mutual funds: essentials investors should know.
• For some assistance on selecting gilt funds, see: How to choose a gilt mutual fund

In summary, UTI Gilt Fund with a 10-year Constant Duration is only suitable for experienced investors. Theoretical investment opportunities may not pan out to be so in reality because there are too many uncertainties at play. Such funds may be suitable for long-term goals but can be highly volatile.